Introduction to the ISDA/IIFM Tahawwut Master Agreement. Tariq Zafar Rasheed

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1 Introduction to the ISDA/IIFM Tahawwut Master Agreement Tariq Zafar Rasheed

2 Overview Background to the ISDA/IIFM Tahawwut Master Agreement (TMA) Shari ah Principles TMA Documentation Architecture Example Mubadalatul Arbaah (Profit Rate Swap) Key Differences with 2002 ISDA Master Agreement Early Termination and Close-Out upon Default Miscellaneous Page 2 Berwin Leighton Paisner

3 Background to the TMA Concerns with conventional derivatives TMA to be used for the purposes of risk management arrangements (NB. tahawwut) Collaboration between the International Swaps and Derivatives Association, Inc. (ISDA) and the International Islamic Finance Market (IIFM) Publication on 1 March 2010 Aims:- Standardising documentation Reducing price divergence between Islamic derivatives and conventional derivatives Benchmark for the industry Published Documents:- TMA Confirmation templates for wa ad-based Mubadalatul Arbaah (Profit Rate Swap) single sale and two sales Explanatory Memorandum Legal Opinion addressed to ISDA Page 3 Berwin Leighton Paisner

4 Shari ah Principles Hedging of actual risks No speculation (i.e. actual settlement of assets and payments must take place) real transactions Asset must be halal No interest Asset based Wa ad (i.e. unilateral undertaking) leading to a murabaha similar to an agreement to agree. Page 4 Berwin Leighton Paisner

5 TMA Documentation Architecture Definitions Supplement Product Supplements ISDA/IIFM Tahawwut Master Agreement Credit Support Documentation (if any) ISDA Protocols Confirmations for Transactions (i.e. concluded Transactions) DFT Terms Confirmations for DFT Terms Agreements referencing Designated Future transactions (i.e. future transactions) Transactions vs. Designated Future transactions English law/ny law Part 4(g) of ISDA Schedule Shari ah (Sections 1(d), 3(h), 3(i) and 4(c)) Arbitration (Section 13(c)) IIFM Shari ah Advisory Panel has only approved the TMA To date, ISDA has not published a Credit Support Annex/Deed for the TMA Page 5 Berwin Leighton Paisner

6 Example Mubadalatul Arbaah (Profit Rate Swap) Party A 4x fixed payments Party B 1 year conventional Interest Rate Swap with 4 quarterly payments 4x floating (LIBOR) payments Wa ad to enter into Murabaha Payment (Cost plus Fixed Rate) Repeat 4 times in 1 year Party A Asset A Asset B Party B Payment (Cost plus Floating Rate) Wa ad to enter into Murabaha Purchase of Asset B Sale of Asset A Purchase of Asset A Sale of Asset B Broker/ Agent Broker/ Agent Broker/ Agent Broker/ Agent Page 6 Berwin Leighton Paisner

7 Example Mubadalatul Arbaah (Profit Rate Swap) (contd.) Two sets of Confirmations Wa ad-based and involving a Two Sales Structure Wa ad-based and involving a Single Sale Structure NB. For Shari ah reasons, distinct transactions /wa ad used for each leg. NB. Executed as deeds. NB. Seller represents to Buyer that assets are free of cumbrances but otherwise sold on an as is where is basis. NB. Disapplication of the United Nations Convention of Contracts for the International Sale of Goods. NB. Various sensitivities regarding brokers/agents. Page 7 Berwin Leighton Paisner

8 Example Mubadalatul Arbaah (Profit Rate Swap) (contd.) Calculation Period 1 Calculation Period 2 Calculation Period 3 Calculation Period 4 Implementation of PRS Wa ad to enter into 4 Murabaha ( DFT Terms Agreement ) or On first Payment Date/Exercise Date: Entry into 1st Murabaha ( Transaction ) Wa ad to enter into 3 subsequent Murabaha ( DFT Terms Agreement ) Timing At end of a Calculation Period, enter into a Murabaha ( Transaction ) Spot delivery of commodity Spot payment of purchase price At beginning of a Calculation Period, enter into a Murabaha ( Transaction ) Spot delivery of commodity Deferred purchase price payable at end of Calculation Period Page 8 Berwin Leighton Paisner

9 Example Mubadalatul Arbaah (Profit Rate Swap) (contd.) Settlement Risks Broker risk Commodity risk Counterparty risk Other Issues Tax Accounting Regulatory capital Page 9 Berwin Leighton Paisner

10 Key Differences with 2002 ISDA Master Agreement Aim to minimise changes with 2002 ISDA Master Agreement Preserving the 3 Pillars Single Agreement (Section 1(c)) Flawed Asset/Conditionality (Section 2(a)(iii)) Close-Out Netting (Section 6) Additional Shari ah undertakings Wa ad to enter into Musawama (Section 2(e)) Additional Shari ah representations Consents (Section 3(a)(iv)) Principal (Section 3(g)) Satisfaction as to Shari ah compliance (Section 3(h)) Non-reliance (Section 3(i)) Tax Designated Future transactions (Section 2(d)(4)(B)) Page 10 Berwin Leighton Paisner

11 Key Differences with 2002 ISDA Master Agreement (contd.) Events of Default Failure to Pay or Deliver (Section 5(a)(i)) Breach of Agreement; Repudiation of Agreement; Failure to enter into a Designated Future transaction (Section 5(a)(ii)) Credit Support Default (Section 5(a)(iii)) Misrepresentation (Section 5(a)(iv)) Default Under Specified Transaction (Section 5(a)(v)) Cross-Default (Section 5(a)(vi)) Bankruptcy (Section 5(a)(vii)) Merger Without Assumption (Section 5(a)(viii)) Page 11 Berwin Leighton Paisner

12 Key Differences with 2002 ISDA Master Agreement (contd.) Termination Events Illegality (Section 5(b)(i)) Force Majeure Event (Section 5(b)(ii)) Tax Event (Section 5(b)(iii)) Tax Event Upon Merger (Section 5(b)(iv)) Credit Event Upon Merger (Section 5(b)(v)) Additional Termination Event (Section 5(b)(vi)) NB. Transfer to Avoid Termination Event (Section 6(b)(ii)) Page 12 Berwin Leighton Paisner

13 Early Termination and Close-Out upon Default What terminates? Event of Default All Transactions All DFT Terms Agreements Termination Event All Transactions All Affected DFT Terms Agreements NB. In the case of Illegality or Force Majeure Event, can terminate less than all Transactions/Affected DFT Terms Agreements Page 13 Berwin Leighton Paisner

14 Early Termination and Close-Out upon Default (contd.) Example (wa ad-based and involving a two sales structure) Floating Rate Wa ad Party A grants wa ad exercisable 4x for one year. Fixed Rate Wa ad Party B grants wa ad exercisable 4x for one year. Floating Rate Wa ad 1 exercised on Effective Date. Floating Rate Murabaha 1 performed. Fixed Rate Wa ad 1 exercised on Effective Date. Fixed Rate Murabaha 1 performed. Floating Rate Wa ad 2 exercised on Exercise Date 2. Floating Rate Murabaha 2 entered into. Commodity delivered by Party B on Exercise Date 2. Floating rate purchase price deferred and payable by Party A on Payment Date 2. Fixed Rate Wa ad 2 exercised on Exercise Date 2. Fixed Rate Murabaha 2 entered into. Commodity delivered by Party A on Exercise Date. Fixed rate purchase price deferred and payable by Party B on Payment Date 2. Early Termination Date designated on 10th day after Exercise Date 2 (i.e. intra-period). Floating Rate Murabaha 1 = Fully Delivered Terminated Transaction Fixed Rate Murabaha 1 = Fully Delivered Terminated Transaction Floating Rate Murabaha 2 = Fully Delivered Terminated Transaction Fixed Rate Murabaha 2 = Fully Delivered Terminated Transaction Floating Rate Wa ad exercisable on 2 dates = 2 DFT Terms Agreements Fixed Rate Wa ad exercisable on 2 dates = 2 DFT Terms Agreements Page 14 Berwin Leighton Paisner

15 Early Termination and Close-Out (contd.) Following designation of Early Termination Date due to Event of Default, Non-defaulting Party makes the following calculations:- (i) Early Termination Amount = Close-out Amount + Unpaid Amounts owing to Non-defaulting Party + Unpaid Amounts owing to Defaulting Party (ii) Relevant Index Amount = Aggregate of the Market Quotation (or Loss) for Non- Fully Delivered Terminated Transactions and Terminated DFT Terms Agreements NB. Close-Out Amount reflects netted accelerated payments under Fully Delivered Terminated Transactions. NB. Unpaid Amounts determined for Fully Delivered Terminated Transactions and Non-Fully Delivered Terminated Transactions. NB. Relevant Index Amount represents the net replacement costs for all Non-Fully Delivered Terminated Transactions and Terminated DFT Terms Agreements. NB. Each of Early Termination Amount and Relevant Index Amount may be positive or negative NB. Need for a real transaction with real asset in respect of Relevant Index Amount (see next slide). However, note timing issues and fallback (i.e. liquidated damages). (iii) Early Termination Amount calculation Positive Indexed Value/Negative Indexed Value Set-off for single amount Page 15 Berwin Leighton Paisner

16 Early Termination and Close-Out upon Default (contd.) Musawama in respect of Relevant Index Amount:- If Relevant Index is positive (i.e. Non-defaulting Party is in the money ), it can exercise wa ad (Section 2(e)) requiring Defaulting Party to enter into musawama and purchase Designated Assets from Nondefaulting Party for the Positive Indexed Value. Positive Indexed Value = market value of Designated Assets + Relevant Index value + VAT, sales tax, etc. Non-Defaulting Party Designated Assets Positive Indexed Value Defaulting Party If Relevant Index is negative (i.e. Defaulting Party is in the money ), Defaulting Party can exercise wa ad (Section 2(e)) requiring Non-defaulting Party to enter into musawama and purchase Designated Assets from Defaulting Party for the Positive Indexed Value. Negative Indexed Value = market value of Designated Assets + absolute value of Relevant Index value + VAT, sales tax, etc. Non-Defaulting Party Negative Indexed Value Designated Assets Defaulting Party Page 16 Berwin Leighton Paisner

17 Miscellaneous No interest payable Transfer Arbitration Page 17 Berwin Leighton Paisner

Your Contact Tariq Zafar Rasheed, Partner DDI: +44 203 400 3290 e-mail:

18 Your Contact Tariq Zafar Rasheed, Partner DDI: Page 18 Berwin Leighton Paisner

19 Introduction to the ISDA/IIFM Tahawwut ISDA Master Agreement Tahirah Ara and Tariq Rasheed Doc ID: This document provides a general summary only and is not intended to be comprehensive. Specific legal advice should always be sought in relation to the particular facts of a given situation.

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